SEC Warns Former JPMorgan Exec It Plans to Sue Over Magnetar Deal

The JP Morgan Chase headquarters in New York on March 17, 2008. (Don Emmert/AFP/Getty Images)

The Securities and Exchange Commission may soon file suit over a mortgage securities deal involving JPMorgan Chase and a hedge fund called Magnetar, Bloomberg reported. Two individuals have been notified of potential charges. They include a former executive at JPMorgan, the bank that created and marketed the security, and a former executive at GSC Capital, the firm that managed the selection of assets.

As we reported last fall, regulators have been investigating whether JPMorgan misled investors about the role that Magnetar, a hedge fund, played in selecting the assets that went into a $1.1 billion collateralized debt obligation created by the bank in 2007. The deal, known as “Squared,” was made up of slices of other CDOs backed by subprime mortgages. (See the prospectus for the deal.)

Squared was one of more than two dozen CDO deals that Magnetar did in the waning days of the housing boom, ultimately helping to create at least $40 billion of CDOs. (It was also one of several deals managed by GSC that also involved Magnetar.) As we detailed last year, Magnetar often pushed for riskier assets to be included in CDOs as part of a strategy to bet against the housing market. Magnetar has consistently denied that strategy and has told us that it would have made money regardless of the direction of the housing market.

The former JPMorgan executive at the center of the investigation, Michael Llodra, was global head of the bank's CDO business. Bloomberg reported that Llodra disclosed in his broker registration filings that he received a notice of potential legal action, or Wells notice, from the SEC in January. Llodra's attorney, Sean Hecker, declined our request for comment.

JPMorgan earned about $20 million for creating the deal, we were told, but the bank ultimately lost about $880 million when the safest slices of the CDO—which the bank kept on its books—lost value. Investors in Squared also suffered significant losses.

The SEC also sent a Wells notice to Edward Steffelin, a former executive at GSC Group, the firm that helped manage the “Squared” deal. Steffelin also declined our request for comment. CDO managers, like GSC, are supposed to select assets for the CDO with the interests of investors in mind.

3 comments

Why not do away with the Wells notice? It’s not required by law to be served and it seems its only purpose is to buy time for the defendant to bargain a settlement. Goldman and the Abacus deal is a perfect example; settlement with no criminal/civil charges just months after receiving a Wells notice. If the SEC has legitimate claims against JPM or any other bank, proceed and file the charges. The Wells notice is nothing more then a free ticket to lobby (behind closed doors) against wrong doing. My bet is JPM “settles” and no charges brought forth - status quo.

Enticed by profits and bonuses, Wall Street took advantage of complicated mortgage-based instruments to reap billions, only to exacerbate the eventual crash.

The Story So Far

As the housing market started to fade, bankers and hedge funds scrambled for ways to maintain the lavish bonuses and profits they had become so accustomed to, repackaging mortgages in complex securities called collateralized debt obligations. The booming CDO market masked how weak the housing market was, and exacerbated its collapse.

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